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Microfinance

Microfinance - Image - Woman knitting

Access to financial services has become an important element of social fund and community driven development projects because the poor must have continuous and permanent access to strong, stable financial systems in order to build their family’s economic security.  In many of the countries and contexts in which social funds operate, there are few viable microfinance institutions, and necessary emphasis on access to finance is lacking. Even in countries with a strong microfinance sector, most low-income families, especially those in rural areas, do not have access to financial services that enable them to build their businesses and meet other needs such as health care and education.

Grants for individual or family income-generating activities may be appropriate in emergency or post-conflict situations to help families rebuild their asset base, or to provide a safety net to the destitute, but they are not a sustainable mechanism for the economic development of the community. Individual and family-owned businesses that are privately financed tend to be more successful.

Microfinance Approaches and Social Funds

The formal financial institutions approach focuses on building strong, stable financial systems that serve the needs of the entire population. This is the preferred approach when there are banks, microfinance institutions (MFIs) and/or financial cooperative/credit union networks that are interested in broadening their outreach to geographically underserved areas and in deepening their outreach to the poor.  Examples: social funds have supported the creation of MFIs (Yemen, Albania), strengthened existing MFIs (Bosnia), provided funding to MFIs to expand to rural areas (Morocco) and provided support for MFIs through commercial banks (Chile).

The community-based institutions approach is appropriate for inaccessible rural communities that cannot attract banks, MFIs or established cooperative or credit union networks. This approach focuses on building strong informal or semi-formal community financial institutions, and linking them with the formal financial sector either directly or through the creation of federations. Examples: CDD projects in Andhra Pradesh, India have supported informal self-help groups that link to banks, while in Sri Lanka this type of project has supported village-based companies engaged in savings and loan activities.  In Tanzania, savings groups have been promoted.

The “rules of the game” that work well for infrastructure subprojects are often not effective for the establishment of sustainable microfinance in SF/CDD “open menu” projects that provide direct financing to communities.  Technical assistance in institution building, including establishment of a legal entity with identifiable owners, governance, management, policies, procedures and financial systems often cannot be procured locally by communities.  Failure to adequately build the institution frequently results in mismanagement of the financial resources provided by the project.

Lessons Learned

Financial services need to be sustainable to provide a permanent recourse to people who need them. The long-term sustainability of microfinance institutions is critical; most organizations need technical assistance and capacity building to achieve this. Access to

  • micro-credit is not sufficient; the poor also need access to savings, insurance and payment services.
  • Credit lines and revolving funds are rarely effective tools for achieving sustainable, cost-effective financial services for the poor.  Revolving funds fail because of inadequate management and sense of ownership of the resources.  Credit lines are destined to be a short-term intervention unless the financial institutions that use them are committed to developing this business line and believe that it can be a profitable niche for them.  In both cases, technical assistance is critical.

Key Challenges

  • Banks and MFIs reach secondary towns, but rarely reach rural communities beyond a 30 km radius of the town.  It is necessary to explore ways to deliver financial services to people in remote locations. 
  • Most microfinance models provide access to short-term loans with regular repayment.  Ways to mitigate the risks of agricultural lending should be explored, so that financial intermediaries are encouraged to develop agricultural loan products.
  • Microfinance is not the solution, at least in the short-term, for the most vulnerable members of the community.  Extremely poor people should not be encouraged to take the risk of a micro-loan and other types of interventions are necessary to build their economic security.
Related Reading

Microinsurance: Extending Pro-Poor Risk Management through the Social Fund Platform (147kb pdf)
Vol. 5 No. 2; October 2008
by Marc Maleika and Anne T. Kuriakose

Graduating the Poorest into Microfinance: Linking Safety Nets & Financial Services (269kb pdf), CGAP Focus Note No. 34, February 2006

Agriculture Investment Note: Microfinance Institutions Moving into Rural Finance for Agriculture
Agriculture Investment Sourcebook, Module 8
World bank Agriculture & Rural Development Dept. (ARD), March 2004

Social Fund Support of Microfinance: A Review of Implementation Experience
Social Protection Discussion Paper No. 0215; 2002
by Alexandra Gross and Samantha de Silva

Guidelines for Designing Poverty-focused Projects with Microfinance Components (34kb pdf)
Developed by the Social Protection Unit in collaboration with the Consultative Group to Assist the Poorest, Financial Sector Development and the Rural and Small Enterprise Thematic Group, December 2002

Country Cases

Timor-Leste: Independent Review of the Credit Component of the Community Empowerment Project
World Bank Social Development Paper, Conflict Prevention & Reconstruction No.11, March 2004
by John Conroy

Holding the Door Open: Facilitating Access to Microcredit in the Benin Social Fund (203kb pdf)
Social Funds Innovation Update Vol. 2 No. 3; March 2002
by John Elder and Maurizia Tovo

Bulgarian Regional Initiatives Fund: Innovative Approach to Income Generation (120kb pdf)
Social Funds Innovation Update Vol. 1 No. 2; October 2001
by Peter Pojarski

Related Websites

Consultative Group to Assist the Poor
The Consultative Group to Assist the Poor (CGAP) is a consortium of 29 bilateral and multilateral donor agencies that support microfinance. Their mission is to improve the capacity of microfinance institutions to deliver flexible, high-quality financial services to the very poor on a sustainable basis.

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